Lenders loaned too much money on too easy terms to borrowers who did not have the capacity to make their payments. No alchemy by even the brightest minds on Wall Street could turn bad loans into good assets.

I have to agree with what Ethan Penner says above in the Wall Street Journal opinion piece, Of Markets and Mortgages – WSJ.com. I disagree with him on several other points. The process of bundling mortgages into securities was way out of control and a major contributing factor to this debacle. As the treasurer for a local Habitat for Humanity affiliate I can say that I am familiar with subprime mortgages. All of our mortgages are subprime mortgages. That is just one of the tools we use to get low income families out of substandard housing. We are a charity and that is part of our mission. In a way similar to the commercial market Habitat for Humanity International offers its affiliates the opportunity to borrow money from HFHI based on a bundle of up to 25% of our mortgage portfolio. Despite the obvious differences between commercial lenders and Habitat, it is interesting to note that the foreclosure rate at Habitat affiliates is remarkably similar to those of commercial lenders until recently. Their foreclosure rates skyrocketed and ours stayed the same. If the commercial lenders were following HFHI’s standards they would hold about 75% of their mortgages. This would have allowed the lenders ample room to find good mortgages in their portfolio to replace the mortgages in default. This was the part of the process that failed. Commercial lenders looked at historical foreclosure rates and assumed they were safe.  By the time they realized the extend of their problem, they had already run out of good mortgages. They were experiencing another one of those difficult to predict Black Swan scenarios.

Ethan outlines several proposals for mitigating the credit crisis and reducing the backlog of foreclosed houses. The big question is how to avoid repeating this crisis. One idea that I did not see mentioned is a regulatory tool modeled after the margin call. I think we would have had a smaller problem if we let the Federal Reserve set the collateral limits for bundled mortgages.  The Federal Reserve could move the limits up and down based on the health of the mortgage market. This would have allowed the Federal Reserve to knock some of the irrational exuberance out of the housing market. Several analysts noticed that the housing market in California and Florida has been crazier than normal since 2000 and were openly wondering when the bubble was finally going to burst. We could have done better!